Account Management System
In an attempt to achieve the company’s new strategy, Mr. Ridderstrale hired a Swedish management advisory group to help his team develop a system to analyze production and S;A costs associated with each order. Over a period of several months of interviews and investigation, the team was able to divide Kanthal’s costs into order and volume costs. Further analysis revealed four major cost drivers associated with order placement and completion:
1. Manufacturing order costs – includes the cost of setup and other activities when ordered products are not in stock. This cost is calculated separately for each product. 2. Manufacturing volume costs -includes raw materials, direct labour, variable overhead, and the cost of production orders to replenish inventory. 3. Sales order costs -includes S&A costs traced to a specific order. 4. Sales volume costs – includes all other S&A costs and is allocated proportionately to manufacturing volume costs. The new system followed the following four step procedure to more accurately calculate the operating profit for an order:
Step-1: Calculate selling and administrative order costs. This was achieved by dividing the total S&A costs by total number of orders executed, including both stocked and non-stocked orders. Step-2: Calculate manufacturing order costs for non-stocked products. This was achieved by dividing the total manufacturing costs (for non-stock products) by the number of non-stocked orders. This step eliminated the disproportionate allocation of manufacturing costs to stocked products.
Step-3: Calculate allocation factor for S&A volume costs. This was achieved by first computing the ‘total volume costs’ by subtracting the S&A and manufacturing order costs from ‘total manufacturing and S;A costs’. Then S&A volume related costs were divided by manufacturing volume COGS to drive at the ‘S;A allocation factor’. Step-4: Calculate operating profits on individual orders for non-stocked products. This was achieved by subtracting the volume related costs (both manufacturing and S&A) from the sales revenues followed by subtracting manufacturing and S&A order costs to obtain the operating profit per order.
This new system enables the management team to analyze order profitability by customer, by product group or by all orders received by a customer in a country. The reports from this system would, for example, show a customer’s bottom line profits broken up by invoice value, volume and order costs, and additional non-stock cost (if applicable) would be traced back to the customer. Now managers are able to see the variability in profits from customer to customer. For example, profit margins for individual orders varied from -179% to +65%, where previously almost all of these orders would have appeared profitable.
The most attractive feature of the new system is its ability to capture the cost associated with non-stock orders. For example, country customer # S005 (from case exhibit 6) shows a profit margin of -42%. Further analysis reveals that this specific order incurred additional stock-out costs since ‘finished wire’ was out of stock. The cost of non-stocked ‘finished wire’ is SEK2,340 and the profit loss on this order was -SEK1,319. If, at the time of the order, ‘finished wire’ was in stock, this customer order would have been profitable. With this information, the team can better prioritize the orders as they come in. They will have the necessary information to decide whether an order should be placed immediately or if it should be delayed until specific inventory parts have been replenished.
Limitations of Kanthal 90 Account Management System Although the new system is more efficient in proportionately allocating the S;A expenses to various products and customers, it has some inherent limitations. For one, it requires a lot of effort and resources to track each and every customer order. The old system’s simplicity is probably the primary reason why the organization did not move to a much more sophisticated accounting system.
Furthermore, it will take time to convince the sales force to change their current behaviour. The new system’s benefits will only be realized if the employees are using the outputs and making sound decisions based on the results. Currently the sales force’s primary focus is on top line growth, however, with the new system, they are realizing that some of their top customers (in sales) may not necessarily be the most profitable. As a matter of fact, two of the most unprofitable customers account for the largest sales volume orders per customer.
Therefore, a change in employee and sale force behaviour is necessary for a successful implementation of the Kanthal 90 system. The top management teams must be prepared for initial resistance to the new system and necessary steps, such as training and educating the employees, will be required to mitigate the level of resistance.